Argentina Default Risk Surges, Currency Collapses As Investors Finally Lose Faith

Mauricio Macri’s presidency was meant to lead Argentina out of a dismal period of debt defaults, currency controls and recession. But, as Bloomberg reports, markets show investors are losing faith in the new dawn for South America’s second-largest economy.

Despite all the constant propaganda spewing forth from officials in Argentina (and at The IMF), we leave it to an old friend and veteran EM trader to sums things up: “The Argies are proper f**ked.”

Indeed, judging by today’s market action and headlines, he is right, as despite the promise of a USD 50 billion International Monetary Fund (IMF) bailout (which is now being accelerated), the Argentine peso continues to collapse, inducing the next wave of inflation, and it could shortly usher in the next recession/depression.

With a run on the peso, Argentines and investors are bracing for financial volatility, which judging by the latest declines in emerging-market currencies – it might have already started – as th epeso has crashed another 4% today to a new record low above 32.5/USD…

Argentina Default Risk Surges, Currency Collapses As Investors Finally Lose Faith

The central bank sold $200 million of its reserves in two currency auctions on Tuesday aimed at stabilizing the peso, which nonetheless weakened to a record close of 31.50 per dollar. Another $300 million were auctioned on Wednesday.

“Over the last week we have seen new expressions of lack of confidence in the markets, specifically over our financing capacity in 2019,” Macri said.

Will Argentina, rather than Turkey, be the first to impose exchange controls which are governmental limitations on the purchase and/or sale of the peso.

USDARS (PESO) SPOT RATE

According to Reuters, economists had pointed out that Argentina’s peso was extremely overvalued, and it seems that the government made the fatal mistake by acknowledging the problem. In April, the peso started its plunge against the dollar, due to investor concerns about the government’s ability to control inflation and the threat of interest rate hikes plus quantitative tightening via the U.S. Federal Reserve, which rapidly strengthened the dollar worldwide.

USDARS Spot Rate 

Argentina Default Risk Surges, Currency Collapses As Investors Finally Lose Faith

With the peso in terminal decline, Argentina’s dollar debts became more expensive for the government, prompting it to tap a USD 50 billion lifeline with the IMF.

Argentina Default Risk Surges, Currency Collapses As Investors Finally Lose Faith

NATIONAL INFLATION Y/Y

While it is evident that Argentina needs to stabilize the peso before the free-falling currency forces the next round of economic pressures to its fragile economy by stoking inflation, Reuters figures that inflation is around 31 percent year over year.

Argentina Default Risk Surges, Currency Collapses As Investors Finally Lose Faith

FOREIGN CURRENCY RESERVES

Argentina seems to be running out of runway with a declining peso severely depleting the country’s currency reserves.

Interest rates have been raised to 45 percent and selling billions of dollars in fx reveres have not convinced investors that the government has the problem under control.

While the IMF loan gave reserves a boost back to April levels, it seems that any further selling of the peso will drain reserves quite quickly.

Argentina Default Risk Surges, Currency Collapses As Investors Finally Lose Faith

ECONOMIC ACTIVITY Y/Y

With inflation surging and rising interest rates choking economic activity, the financial storm in Argentina is only getting started. To make matters worse, a devestating drought has decimated the harvest of soybeans and corn, said Reuters, adding that agriculture is the backbone of the economy.

As shown below, the economy has contracted for three straight months, with the agricultural sector baring the most weight on the slump — as some economist told Reuters that a recession is on the horizon.

Economic data shows GDP dropped by 6.7 percent in June, “the worst monthly fall since the global financial crisis of 2009,” concluded Reuters.

Argentina Default Risk Surges, Currency Collapses As Investors Finally Lose Faith

“Meanwhile, a clear move to greater fiscal discipline to restore investor confidence seems to be an implausible option for the government. Not only would budget belt-tightening likely deepen the economic recession toward which the country now seems to be lurching, it is also that the Macri government would not seem to have the political support for such belt-tightening, especially ahead of next year’s general election. Since having called in the IMF for assistance, President Macri has seen his support at the polls drop from 50 percent to 35 percent.

In December 2015, at the start of his presidency, the Macri government made the crucial mistake of lifting all exchange controls before stabilizing Argentina’s economy and before aggressively embracing deep economic reform. The government now seems likely to have to pay dearly for that mistake. With the currency plummeting and with other options having run out, President Macri may very well soon be forced to reintroduce exchange controls to put a floor to the currency’s damaging free fall,” said Desmond Lachman, a Resident Fellow at American Enterprise Institute.

Visualize the emerging market currency crisis in one chart — it is a global problem.

Argentina Default Risk Surges, Currency Collapses As Investors Finally Lose Faith

Emerging markets/G7 FX volatility ratio just hit its all-time record high – higher even than 2008 and the global financial crisis. Could there be a much larger storm brewing just not in Argentina?

Argentina Default Risk Surges, Currency Collapses As Investors Finally Lose Faith

And finally, just in case you forgot, Argentina (the most-defaulting nation in world history) issued a 100-year bond last year (and it was over-subscribed). Things are not going so well for those ‘reaching’ for that yield…

Argentina Default Risk Surges, Currency Collapses As Investors Finally Lose Faith

Argentina’s yield spread over Treasuries — the extra cost it pays to borrow in the bond market compared with the U.S. — has climbed this month to the highest since December 2014. The spread surpassed Ecuador’s, which has the dubious distinction of having the second-most defaults in the world since 1800, for the first time since May 2015.

Argentina Default Risk Surges, Currency Collapses As Investors Finally Lose Faith

An early release of funds from the IMF could help to stabilize Argentine assets, according to Frances Hudson, a global strategist in Edinburgh at Aberdeen Standard Investments.

“Otherwise, it’s edging closer to a crisis in a region that seems vulnerable and volatile on a number of fronts,” she said.

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